One of the first things that your advisors will tell you when you start up your company is to legally separate your personal finances from your company finances. This separation is one of the biggest benefits of incorporating early. Legally separating yourself from your company helps keep your personal finances and livelihood protected if things in your company go south (and vice versa).
To put it more plainly: if your company has to declare bankruptcy, you do not have to worry that a judge will come after your personal assets as a means to resolve your company’s debt issues.
Nobody wants to think about things like bankruptcy when they first start up a company. All you want to think about are the piles of profit you’ll be raking in with your awesome products or services. Still, it is important to understand how bankruptcy works from a corporate and business standpoint, especially if you want to protect yourself from legal issues. Here are some of the basics that you need to understand.
Bankruptcy Is a Last Resort
This is true both for personal finance as well as your company’s finances. If your company lands in hot water and finds itself unable to pay suppliers or pay properly on its debts, it is vital that your company do everything it can to resolve those debts and accounts before you declare bankruptcy. Even if you have to close a few locations down or reduce your staff (as much as that will hurt), it is better to do what you can to keep the company afloat. It sounds harsh, yes, but this is business.
Chapter 11 is Better
While there is, technically, no “good” type of bankruptcy, Chapter 11 is one of your best options. Chapter 11 allows your business to stay open and gives you some room to restructure your company so that it will run better and be more profitable. You will do this under the watchful eye of a court appointed trustee. Chapter 11 is the title that Radio Shack is using for its recent bankruptcy filings. If you think that you can restructure and rebuild, Chapter 11 is the way to go.
If you are sure that there is zero hope for recovery, however, you’ll probably want to file Chapter 7. According to Doan Law, Chapter 7 is used for both personal and small business bankruptcies and it liquidates all of a company’s assets and then uses the money from the liquidation to settle as many accounts as possible.
Paying Yourself Gets Trickier
One of the things that happens when you separate yourself from your company financially is that you then become a de facto employee of the company. Instead of pocketing profits, you are paid a wage from the company’s accounts. If the company goes bankrupt, recouping lost pay (even pay that you forewent in an effort to save the business) gets tricky. You will be considered one of the creditors to whom money is owed and the court will decide how much you get paid.
A lot of small business owners try to at least pay themselves before filing for bankruptcy. Don’t do this! When you declare bankruptcy, the court will look at all of your company’s payments over the last year and if you are listed in the ledgers you will have to give back what you were paid so that it can be distributed fairly. You might also land in some legal trouble. It is better to eat the loss and let the court handle it.
Always Hire Help
Never try to navigate your company’s bankruptcy yourself. Always hire a lawyer who specializes in corporate and small business bankruptcy to help you file. Corporate and small business bankruptcy is incredibly complicated. What we’ve touched on here is just the beginning.
Finally, remember that bankruptcy doesn’t have to mean the end of the road for your entrepreneurship. Even if you file under Chapter 7, you can take what you’ve learned and try to build something new. It might take some time, but you will recover.